Why financial firms should reflect tech-related emissions in their ESG reporting

Firms that work with their technology providers to increase transparency over, and ultimately tackle, emissions associated with storing data, using software and technology waste will be better able to demonstrate their actions on combating climate change and resist growing climate-related scrutiny that can threaten their reputation.

Reporting requirements

A growing number of financial services firms active in the UK must comply with the Financial Conduct Authority’s (FCA) environmental disclosure requirements. These implement otherwise voluntary global reporting standards created by the Task Force on Climate-related Financial Disclosures (TCFD).

The FCA’s reporting obligations came into effect in December 2021 and apply to accounting periods beginning on or after 1 January 2022. Therefore, we can expect to see the first reports addressing the FCA’s new requirements to be published in early 2023.

The FCA’s requirements apply to:

• premium listed companies;
• issuers of standard listed shared and global depositary receipts;
• asset managers;
• life insurers; and
• FCA-regulated pension providers.

Asset managers and asset owners with less than £5 billion in assets under their management or administration, calculated on a three year rolling average, will not be subject to the FCA’s requirements until 1 January 2023.

As part of its net zero strategy, the UK government introduced reporting requirements which are similar to those of the FCA. These apply to UK registered companies and LLPs with a turnover in excess of £500m and more than 500 employees, as well as all publicly quoted UK companies.

In its explanatory guidance, the UK government addressed the fact that there is now an overlap between its new requirements and the FCA’s, which means that some UK companies with more than 500 employees will now be subject to both regimes. The government stated that reporting which complies with all of the TCFD’s requirements is “normally likely” to meet the requirements of both the UK government and the FCA regime. The government’s reporting requirements apply for accounting periods beginning on or after 6 April 2022.

‘Scope 3’ emissions

A common theme across the FCA and UK government’s regimes is expectations around reporting on carbon emissions. Recent international trends in reporting on carbon emissions have identified three broad areas, or ‘scopes’, in which financial services firms are now be expected to make disclosures:

• Scope 1: carbon emissions created directly by the institution itself;
• Scope 2: carbon emissions caused by the institution’s purchase of energy from an energy provider; and
• Scope 3: all indirect carbon emissions which are created as part of the institution’s operations, but which come from sources which it does not control or own.

Whilst reporting on scope 1 and 2 emissions is mandatory under the FCA and UK government’s regimes, reporting on scope 3 emissions is not, though there is one small exception on business-related travel for companies which are not listed on the stock exchange. However, there is growing attention in the media in relation to voluntary scope 3 reporting and financial services firms should consider the potential reputation damage of failing to report on these.

As scope 3 emissions come from sources which firms do not control or own, they must liaise with their suppliers to evaluate what emissions are relevant for disclosure and how they might address them. This process should involve:

• Assessing the supply chain: firms should analyse their supply chains and identify all suppliers which produce carbon emissions which fall within scope 3;
• Engaging with suppliers: following the initial analysis stage, firms should liaise with their suppliers to agree a plan for gathering information on scope 3 emissions. This should include consideration of the methodology for carrying out assessments of scope 3 emissions, as well as clearly defined metrics;
• Calculating emissions: once individual suppliers have provided the relevant information, firms should collate these responses and calculate their overall scope 3 emissions for the relevant reporting period;
• Continuous improvement: as well as reporting scope 3 emissions to regulators annually, firms should work with their suppliers to set emissions targets and create strategies to improve these on an ongoing basis to decrease their scope 3 emissions.

Technology in the financial services sector

Given the ever-increasing use of technology in the sector, a large portion of the scope 3 reporting for financial services firms will be made up of carbon emissions from technology providers. There are several important areas which firms should consider in particular:

• Data retention: firms hold vast amounts of data. According to a study by Cognizant published in 2019, large financial institutions hold, on average, around 386 terabytes of data. The storage of this data has serious consequences for scope 3 emissions. Firms must therefore work with their suppliers of data storage solutions to implement appropriate data retention policies;
• Data storage: data centres account for approximately 1% of global electricity use. The servers they house require cooling systems which represent both significant energy consumption and high operational costs. As tenants of data centres, financial services firms must work with data centre owners to improve their energy efficiency. Some organisations have already started partnering with data centres to lower carbon emissions using solar and renewable energy. This can be an attractive arrangement since lower operational costs means that cost savings can be passed down to customers;
• Technology waste: the pace of technological change means that technology products are now becoming outdated and being replaced more frequently. As a result, firms should consider working closely with suppliers to ensure that technology is only replaced when needed and that appropriate maintenance and recycling programmes are put in place. Firms may also wish to audit the use of technology to ensure that full use is being made of resources;
• Software efficiency: firms should recognise that their software can also have an impact on their scope 3 emissions. Whilst this may be more complex to assess than other areas of scope 3 emissions, firms should nonetheless work with their software providers to establish appropriate metrics to measure its environmental impact, and explore the development of more eco-friendly software solutions. For example, there is a growing trend towards offering ‘low data’ options to users of websites and online platforms which could be implemented across the financial services sector.

Our view

While reporting on scope 3 emissions is not currently a regulatory requirement for financial services firms, there is growing expectation in the market that firms will do so.

Increased reliance on technology has led to an increase in carbon emissions in supply chains and firms should ensure that sustainability objectives are reflected in arrangements with suppliers, including through contractual provisions, to effectively mitigate their impact on the environment.

Co-written by Michael Livingston of Pinsent Masons.